Is There An Opportunity With Trip.com Group Limited's (NASDAQ:TCOM) 28% Undervaluation?

Key Insights

• The projected fair value for Trip.com Group is US$47.31 based on 2 Stage Free Cash Flow to Equity
• Trip.com Group is estimated to be 28% undervalued based on current share price of US$33.91
• The CN¥50.36 analyst price target for TCOM is 6.4% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Trip.com Group Limited (NASDAQ:TCOM) by taking the expected future cash flows and discounting them to today's value. This will be done using the Discounted Cash Flow (DCF) model. Don't get put off by the jargon, the math behind it is actually quite straightforward.

We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

See our latest analysis for Trip.com Group

The Method

We use what is known as a 2-stage model, which simply means we have two different periods of growth rates for the company's cash flows. Generally the first stage is higher growth, and the second stage is a lower growth phase. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) estimate

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF (CN¥, Millions)	CN¥11.6b	CN¥13.9b	CN¥14.6b	CN¥16.3b	CN¥17.6b	CN¥18.6b	CN¥19.6b	CN¥20.4b	CN¥21.1b	CN¥21.8b
Growth Rate Estimate Source	Analyst x9	Analyst x9	Analyst x3	Analyst x2	Est @ 7.85%	Est @ 6.16%	Est @ 4.98%	Est @ 4.15%	Est @ 3.57%	Est @ 3.17%
Present Value (CN¥, Millions) Discounted @ 9.7%	CN¥10.6k	CN¥11.5k	CN¥11.0k	CN¥11.3k	CN¥11.1k	CN¥10.7k	CN¥10.3k	CN¥9.7k	CN¥9.2k	CN¥8.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = CN¥104b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 9.7%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = CN¥22b× (1 + 2.2%) ÷ (9.7%– 2.2%) = CN¥299b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= CN¥299b÷ ( 1 + 9.7%)¹⁰= CN¥119b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is CN¥223b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$33.9, the company appears a touch undervalued at a 28% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. If you don't agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Trip.com Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 9.7%, which is based on a levered beta of 1.227. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Trip.com Group

Looking Ahead:

Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. What is the reason for the share price sitting below the intrinsic value? For Trip.com Group, we've put together three important factors you should further research:

1. Risks: We feel that you should assess the 1 warning sign for Trip.com Group we've flagged before making an investment in the company.
2. Future Earnings: How does TCOM's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NASDAQGS every day. If you want to find the calculation for other stocks just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.